There’s an economic principle called ‘comparative advantage.’ What this means is that there’s an advantage to having one person or entity produce one output over another.
The best example of this principle is the pizza and beer example. Let’s say that I (Richard) can produce 10 pizzas or 4 beers in an hour. Now, let’s say that Jennie can produce 4 pizzas and 3 beers in an hour. It would make more sense to have me producing strictly pizza and her producing strictly beer because of this principle. Here’s why:
All Pizza: 14 pizzas
All Beer: 7 Beers
R Beer, J Pizza: 4 Pizza, 4 Beers
R Pizza, J Beer: 10 Pizzas, 3 Beers.
Each Half: 7 Pizza, 3.5 Beers
As you can see, we sacrifice 3 pizzas for every half of a beer extra produced. Even though Richard produces more beer per hour than Jennie, he produces vastly more pizza per hour than her, and that’s where the comparative advantage comes in. You want to produce the thing you’re best at compared to everyone else. By doing so, you’re benefiting everyone in the system.
By taking advantages of comparative advantages in business, you’re creating significant value within your company. You can do so by efficiently allocating your employees through strengths tests or by outsourcing many of your needs to experts and professionals who handle these things.
Here’s a real world example: In your business, you may spend 8 hours a month working on billing and accounting. An accountant would take 1 hour to do the same task but will bill you $120. If your time is worth more than $15 per hour, employing this accountant for his comparative advantage would make great business sense. You can do the same thing with sales, HR, marketing, legal, and more, starting at the thing that, when replaced, would generate the highest rate of return (value gained divided by value lost).
Let’s say you value your time at $25 per hour. Here’s a chart to demonstrate rate of return:
|Hours Gained||Money Paid||ROR|
|Accounting||8||$120||(8*25)/120 = 167%|
This table is, of course, assuming that you did each job perfectly and that you’re replacing yourself with someone who does the job exactly as you did. In this case, with all the assumptions in place, you should replace interviewing candidates first because there’s a 250% rate of return for doing so. If, after you replace interviewing, you have $120 left over, you should replace accounting as well because that has a 167% rate of return, which is higher than the remaining choices.
Also, you should never replace something that has a lower than 100% rate of return in this table. This is usually your higher level business functions like planning your company’s future and the board meetings example above.
In a more accurate table, we’d also want to reflect the gained value from hiring others to do certain aspects of your job. Looking above, if you hire an expert to do your marketing, you’d likely see higher than 114% rate of return because a marketing expert is going to be far better than you at marketing your product. You could see more customers, better customers or higher customer retention because of this hire as well as freed up time that you can spend on higher level tasks.
All in all, comparative advantage is your friend. The business owner who can spot these and take the highest advantage of them is the business owner who will be the most successful. One word of caution is that not all outsourcing will yield the rate of return you need. You will still need to ensure that you’re hiring a person who fits your company values and is good at what he or she does. Do not rely strictly on value propositions or price for this analysis. Getting references or meeting your professionals through referrals will help ensure you find the right person for the job.